This is important because although the bank has also cut its unemployment rate forecast from 6.3 per cent to 5.9 per cent for the year, it is wage inflation that remains the key driver to influence interest rate policy. And the fact that employers can increase output by employing more people rather suggests that there is still some slack to rein in. The Bank thinks so too, and has reduced its estimate of the amount of slack in the economy from 1-1.5 per cent to just 1 per cent. All told, the squeeze on disposable income remains in place because estimated wage growth has now fallen back below the forecast inflation rate for next year of 1.7 per cent.
Unfortunately, past experience has shown that formalising guidelines has usually led to red faces all round; the unemployment rate is a classic example. So while there will be greater emphasis on monitoring wage growth and unit costs, there is no specific point at which growth in either will trigger a rate rise. This propensity to shift the goal posts doesn’t help financial markets one way or the other. In fact, the ripple effects are also starting to make a difference. Sterling for example, posted its biggest one-day fall since May, taking it to a 10-week low against the dollar as speculators jumped ship.
The bank’s major challenge is to make a decision on rates within a very small time slot. This slot exists between taking action too soon or too late. Acting too soon could kick the legs out of the economic recovery; acting too late would take us back to the bad old days when the bank spent its time playing catch-up with rising inflation. About the only aspect that does remain pretty certain is that when monetary policy does start to tighten, the increase in interest rates will be a gradual affair.
